Corner Office | By Deborah L. Cohen
Submarina California Subs, a fast-growing San Diego-based sandwich chain, is looking to raise some $3 million to $5 million in capital to shore up its operations during the downturn and invest in store-level advertising for its franchisees.
The closely held company, which independently invested enough cash to more than double its store count to 70 in the past year and a half, is close to securing a private placement from a small syndicate of wealthy investors who were carefully recruited by its investment banker.
“We don’t have too much air when it comes to working capital,” says Chief Executive Jeff Warfield, who in 2004 began a costly rebranding program to prepare the 31-year-old business for aggressive growth. “We’re looking to strengthen the balance sheet, hold down the fort.”
While large-scale private-equity deals have stalled—the victim of a stagnant IPO market and the overall liquidity crisis—smaller, more manageable pools of capital are still finding their way to growing companies in the restaurant sector that have solid track records and the tenacity to endure a competitive environment for limited funds.
In early January, at least two such concepts received P/E funding.
Argo Tea Café, a Chicago-based chain of a dozen specialty teahouses, secured an undisclosed amount raised by San Francisco-based investment bank Thomas Weisel Partners. The company, which has seen annual revenue growth of more than 40 percent, will use the money to open new stores and take advantage of licensing and wholesale opportunities.
Vapiano, a global chain of fast-casual Italian restaurants, received $7 million from an undisclosed strategic equity partner as part of a larger $70-million funding package, mainly from European banks, to fuel U.S. and international growth. The chain’s foreign reach includes markets as far-flung as Australia, Romania, and Mexico.
Smaller private-equity infusions are likely to characterize the capital-raising landscape in the foreseeable future, says Dennis Monroe, chairman and senior partner with Krass Monroe, a Minneapolis-based law firm specializing in restaurant M&A transactions.
Large diversified firms such as Cerberus Capital Management have exited the restaurant space, Monroe says. Meanwhile, dedicated restaurant industry investors such as Sentinel Capital Partners and American Securities Capital Partners remain active. New specialty players such as CapitalSpring are hunting for prospects. In addition, investment bankers are sometimes putting together smaller syndicates when they spot a good opportunity.
“You’re seeing selective groups,” Monroe says. “There’s more risk, obviously because you don’t know what your exit is going to be.”
On the franchisor side, Monroe sees the ability to raise capital amounts of roughly $5 million to $20 million, while he estimates that franchisee deals will track in the range of $500,000 to about $6 million.
With their value orientation, quick-serve and fast-casual concepts remain the sweet spots of the restaurant industry, particularly as consumers trade down to more affordable choices during a recession, says Amy Forrestal, managing director with Brookwood Associates, an Atlanta-based investment firm specializing in middle-market companies. In addition, their smaller store footprints require less cash for build-outs than casual-dining or upscale concepts and can be rolled out more quickly.
“For a good brand with the value proposition—I think people will still be interested,” Forrestal says. “The prices have come way down—and the question is, have the sellers adjusted to what the buyers are willing to pay?”
Besides the difficulty of locating willing investors, operators are facing much lower valuations for their concepts. Rather than garnering deals worth 10 times cash earnings or more, today’s transactions are likely to be conservatively priced at about five times, she says. That is forcing entrepreneurs to make some tough decisions.
“The challenge is, if you’re raising money, you’re probably going to have to give up more of the equity, either in warrants or preferred stock,” Forrestal says.
Jason Scott, part owner of The Taco Truck, an early-stage all-natural taco concept in Hoboken, New Jersey, has found that investors want more control than he and his partners originally expected. When the team began raising capital in late 2008, they were essentially looking for a silent partner to fill in the gaps where friends and family, who contributed $500,000 in startup funds, had left off.
After having various doors in the private equity community closed, Scott eventually found several small New York funds willing to consider putting up the $1.5 million to $1.75 million his company sought to help fund an initial location, but not without requiring voting rights and a higher-than-expected portion of the concept’s retained earnings.
“They definitely want to have their finger on the pulse and be more involved than we initially wanted,” says Scott, who is starting the restaurant venture with a former executive from the upscale China Grill chain.
In addition, the due diligence process has become more stringent, making it imperative that operators are prepared to bare all to would-be investors. Deals that used to take three months are often taking six to nine months in the cautious economic environment.
“You want to have your development costs very tight, you want to know exactly what your build-out costs are, exactly how you’re preparing for volatility in food costs,” says Laird Koldyke, managing partner of Chicago-based Winona Capital Management, which counts Boloco, a fast-casual burrito chain in the Boston area, among its portfolio of investments. “You need to be battening down the hatches for negative comps, even in your best stores,” he says.
For many on the hunt for working capital, the market opportunities outweigh the hurdles of longer wait times and the higher cost of capital.
Dan Rowe, president of the Alexandria, Virginia–based franchise development company Fransmart and Vapiano’s corporate owner, says the increasing affordability of real estate makes expansion opportunities for good operators too good to pass up.
“The real-estate conditions are too compelling not to figure out the capital,” he says.